Welcome to CrossFirst Bankshares Incorporated Second Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode during the presentation. Please note, this event is being recorded. [Operator Instructions] I would now like to turn the call over to Heather Worley, Director of Investor Relations. Please go ahead..

Good morning, and welcome to CrossFirst Bankshares second quarter 2022 earnings conference call.

Before we begin, please be aware this call will include forward-looking statements, including our business plans, future financial performance and the acquisition of Central, which as we mentioned on the announcement call is how we will refer to Farmers & Stockmens Bank.

It operates as Central Bank & Trust in Denver and Colorado Springs and Farmers & Stockmans Bank in New Mexico. These comments are based on our current expectations and assumptions and are subject to risks and uncertainties that could cause actual results to differ materially from these statements.

Our forward-looking statements are as of the date of this call and we do not assume any obligation to update or revise them, except as required by law. Statements made on this call should be considered together with the risk factors identified in today's earnings release and our other filings with the SEC.

We may be referring to adjusted or non-GAAP financial measures, a reconciliation of non-GAAP financial measures to GAAP financial measures can be found in our earnings release. These non-GAAP financial measures are not meant to be a substitute for or superior to financial measures prepared in accordance with GAAP.

This presentation will include remarks regarding the second quarter financial results from Mike Maddox, President and CEO of CrossFirst Bankshares; Ben Clouse CFO of CrossFirst Bankshares; and Randy Rapp, President of CrossFirst bank. At the conclusion of our prepared remarks our operator Jason will facilitate a Q&A session.

At this time, I would like to turn the call over to Mike Maddox, who will begin on slide four of the presentation.

Mike?.

Thank you, Heather. Good morning, everyone, and thank you for joining us today as we discuss our second quarter 2022 results. This is an exciting time for our company with the pending acquisition of Central Bank, which was announced in June.

I'm pleased to share that we've submitted our regulatory application and are actively planning for an anticipated close in the second half of this year. As we continue to get to know the Central team, it confirms our view that our companies are a great cultural fit.

And we expect the combination will deliver enhanced products and services for our clients. As I mentioned during the announcement call, we believe this merger is a great right opportunity for both CrossFirst and Central.

We are confident the addition of top tier talent like Scott Page and his team make this deal a win for CrossFirst and our shareholders.

The deal is expected to bring all of Central's market leaders, a private banking line of business that is well established in Denver, low cost deposits and an experienced SBA team that we can leverage across our existing markets and a mortgage operation that can create additional fee income opportunities.

The ability to provide enhanced technology and expanded products and services, paired with our larger balance sheet will deliver added value for our clients and shareholders. This transaction is immediately accretive for our shareholders and will deploy a portion of our capital for growth with an estimated earn back under three years.

As you know, talent acquisition and development is a major component of our corporate strategy. We have added 13 new producers this year, including eight in the second quarter. We believe our entrepreneurial culture is a differentiator and helps us attract high caliber talent.

Ensuring that we have the right leadership in place is critical to executing on our strategic initiatives. An excellent example of this is the promotion of Randy Rapp as President of CrossFirst Bank. Randy will oversee sales and business development, technology, infrastructure, operations along with his oversight of credit and risk management.

His promotion also allows me to focus on the company's long term vision to achieve strategic and sustainable growth, evaluate the challenges of a rapidly evolving banking landscape and spend more time with our shareholders, customers and prospects. We hired a new General Counsel this past quarter, Amy Abrams.

She is responsible for the oversight of CrossFirst's legal affairs and corporate governance matters and brings a wealth of experience in public company and securities law matters. We continue to advance our market expansion in Texas with the approval of our regulatory application for our new Preston Center location in the Park City's area of Dallas.

We are happy to announce the hiring of Cody Kiser to lead our entrance into the Fort Worth market. His deep Fort Worth routes and he has -- and his team have significant experience with middle to upper middle market companies in the Fort Worth area. We expect to be filing our regulatory application for our Fort Worth location in the near future.

As a part of our strategy to add talent to help us scale, we have hired a new operational leader, JC Feaster, who will serve as Chief Operating Officer of the bank. JC has a strong operational background and will be instrumental in continuing to optimize our processes and efficiencies as we expand. Turning to our financial performance.

We reported $15.5 million of earnings, and our team produced $179 million of loan growth during the quarter, which is an annualized rate of over 16%. We know growth without strong credit is not sustainable.

I'm proud of the improvements we've made in our credit quality and the work our team is doing to ensure we closely monitor the impacts of rising rates and a shifting economy. We must manage risk appropriately and take a balanced approach as we build long term value for our shareholders.

We continue to focus on technology and providing an exceptional client experience. The implementation of our new digital platform for clients is on schedule and we expect to go live in the fourth quarter. This will provide a unified digital experience across all channels. Most importantly, we are committed to driving shareholder value.

With another quarter of solid earnings, we added to our strong capital position while investing for our future. We have continued our stock buyback initiative, as well as invested in technology and talent for future growth. We are well positioned with a great team supporting dynamic markets.

And I couldn't be more excited about what we can accomplish the rest of this year and beyond. Our team continues to execute as one team, one bank with a shared vision of excellence. Now, I will hand the call over to Ben to cover financial results in more detail..

Thank you, Mike. And good morning, everyone. As Mike indicated, we earned net income of $15.5 million or $0.31 per share this quarter and we maintained our solid loan growth. Quarterly return on average assets was 1.12% and return on average equity was 10.15%.

These ratios were the result of strong core performance despite some outsized costs during the quarter. We are happy with the consistency of these ratios, which are driven by strong earnings and the execution of our growth strategy. Our interest income in the second quarter increased 11% on a linked quarter basis to $52.8 million.

This was driven by rate increases, strong loan growth and accrual improvements, which was $1 million of the change. Interest income also includes one additional day in the quarter, which was offset by lower loan fees, primarily due to PPP loan forgiveness.

Our average loan balances were up 2.4% quarter-over-quarter and average yield was up 28 basis points. Interest expense was up $1.5 million for the quarter due to rising rates. Our %age of demand deposits remained consistent, despite the competitive rate environment.

Overall, our cost of funds increased 11 basis points this quarter, mostly due to rates and to a lesser amount increased borrowings and wholesale funding. Our total deposits beta against the FOMC increases this year was about 30 through the end of the second quarter.

Though we made some rate moves at the end of June that will push that somewhat higher for the rest of the year. Net interest margin was up significantly to 3.52% on a fully tax equivalent basis.

We expect margin to remain in a consistent range through the first half of the year or potentially expand in the rising rate environment, although deposit, migration and pricing could be headwinds.

Our balance sheet sensitivity expanded with 70% of our earning assets repricing and maturing over the next 12 months, with much of that being in the first 90 days. I would also note, we no longer have any significant amount of loan rate floors in effect.

Non-interest income for the quarter was $4.2 million and declined about $700,000 from first quarter due to lower credit card transaction volume, partially offset by better treasury fees.

We remain focused on increasing credit card volume and we had notable growth in the number of credit card clients during this quarter, increasing the diversity of this revenue stream. Non-interest expenses for the quarter were $29.2 million, up $1.6 million from the first quarter.

This increase was due almost exclusively to employee separation costs and costs related to the Central acquisition. Salaries and benefits decreased to a more normalized level as the first quarter included incentive payments and related taxes. We also experienced an expected increase in technology spending related to our digital product conversion.

We anticipate non-interest expense to be in a range of $28 million to $29 million for the next two quarters, outside of additional merger costs that we'll see around the closing. We will continue to manage our cost base tightly given the current environment and strike a balance between growing earnings and investing for the future.

Our tax rate was 20.5% for the quarter, up slightly from last quarter and in the range we expect for the rest of the year. Turning to the balance sheet, we had robust loan growth this quarter, as Mike mentioned, at 16% % on an annualized basis. Deposits were up nearly 3% from first quarter, with modest growth in non-interest bearing deposits as well.

Notably, our non-interest bearing deposits are up 42% over a year ago. And our bankers remain focused on growing DDA accounts. Our capital ratios remain strong as we generated significant earnings. We experienced some additional unrealized losses to the securities portfolio as longer term rates moved up right at the end of the quarter.

But we believe this will resolve in the longer term as the interest rate environment moves through the cycle. We intend to continue to hold our securities until values improve and we exclude the unrealized loss from our regulatory capital calculation.

We repurchased 238,000 shares in the second quarter and we will continue our buyback under the additional Board authorization we received in May. With strong loan growth this quarter, our loan to deposit ratio increased slightly to 95%.

As I noted, we had factored some deposit rate increases near the end of the quarter to drive additional deposit growth and we have significant capacity for borrowing or wholesale funding if needed. We had another great quarter and are well positioned going into the second half of the year.

I would like to turn it over to Randy for a more detailed discussion of credit and the loan portfolio..

Thank you, Ben, and good morning, everyone. I'd like to take this opportunity to express my appreciation to Mike, our Board of Directors and our management team for their support and confidence as I begin my role as President of the Bank.

I look forward to working with this dedicated, driven and talented team of banking professionals to deliver outstanding financial performance as we continue to expand and grow our company.

In my new role, I will continue to have oversight of credit and risk and have confidence in the leaders of those vital areas, as well as the people, processes and procedures we have added and implemented over the past several years. Maintaining good credit quality metrics will be a key objective moving forward.

We continue to actively monitor the uncertain economic environment and our loan portfolio by routinely visiting with our clients to understand potential impact to their businesses and financial performance.

We recently completed a thorough loan portfolio analysis applying stress factors to interest rates and operating profits to identify potential weaknesses. This exercise affirmed our current grade accuracy and resulted in minimal grade changes in the portfolio.

Enhanced portfolio monitoring will be imperative, given the increases in inflation rates, short term interest rates, supply chain disruptions, employee wages and commodity prices, which could impact portfolio performance moving forward.

As previously mentioned, in Q2, we reported a 4% quarter-over-quarter loan growth rate or 16% on an annualized basis. We experienced loan growth centered in C&I and commercial real estate portfolios with a large percentage of the growth this quarter coming from C&I.

The energy portfolio continued to decrease during the quarter, dropping $37 million to $226 million or 5% of our total loan portfolio. The portfolio turnover rate stabilized during the quarter, but remained slightly above our historical average, illustrating the higher continued level of loan payoff activity.

We expect this turnover rate to continue to decrease over the next several quarters. C&I line utilization increased during the quarter to 50% from 42.5% in Q1 of 2022. In Q2, we experienced improvement in some of our key credit metrics. As slide 12 illustrates, in Q2 we saw a slight increase in our classified loan totals.

Classified loans increased 9.8% during Q2 to $80.5 million. The increase was attributable to downgrades in the C&I portfolio related primarily to credits negatively impacted by supply chain issues. Classified totals in the energy portfolio reduced 25% in Q2 to $12 million and now represent 15% of total classified loans.

Our classified loan to total capital and combined allowance for credit loss reserve ratio ended the quarter at 12% up from 10.7% at the end of Q1. We expect this ratio to remain in this range in 2022, but could see some short term volatility based on the current uncertain economic environment.

In Q2, non-performing assets decreased $4.8 million to $30.8 million or 0.54% of total assets due primarily to decreases in several C&I and energy transactions. Over the past year, NPAs have decreased from 1.09% of total assets to 0.54% of total assets. 19% of non-performing assets remain in the energy sector, down from 46% in Q2 2021.

This sector continues to be positively impacted by the sustained higher commodity prices. At the end of Q2, we had a combined allowance for credit losses to non-accruing loan ratio of 221%. Moving to slide 13, net charge offs for the quarter remained low at $1.1 million, resulting in an annualized net charge off ratio of 10 basis points.

The net charge off rate for the trailing 12 months was 9%, down 9 basis points, down from 13 basis points the prior quarter. We expect this lower rate to better represent the anticipated net charge off activity for the remainder of 2022.

As previously messaged, we adopted CECL on January 1, 2022, so this is our second quarter reporting under this methodology. At the end of Q2, we reported a combined allowance for credit losses of $61.1 million or 1.35% of total loans.

The combined allowance includes the allowance for credit losses on loans of $56 million and reserves for unfunded commitments of $5.1 million. For the quarter, the bank reported provision expense of $2.1 million compared to a small release of reserves of $625,000 in Q1. Our provision to net charge off ratio for Q2 was 193%.

In closing, we are pleased with our balanced loan growth, improvement in non-performing asset balances and lower quarterly net charge off activity. We continue to closely monitor the US and global economic indicators for potential impact on our markets, clients and prospects as we evaluate our portfolio and new credit opportunities.

We are fortunate to be located in some high job growth markets with more favorable economic trends. I look forward to answering any questions you might have shortly. This wraps up our prepared remarks. And now, I'll turn it back over to the operator to begin the Q&A portion of the call..

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Michael Rose from Raymond James. Please go ahead..

Hey, good morning. Thanks for taking my questions..

Good morning, Michael..

Good morning. Just wanted to start on the loan growth outlook. So, you reiterated the guidance. I think what I'm hearing is relatively positive given the markets that you're in. Obviously, the Frisco office and the Phoenix expansion and the deal will help at some point down the road.

But why did you not raise that guidance? I guess I'm trying to figure out, I mean, do you expect slowdown? Is some of its self-imposed? Is it just given maybe competition and the ability to fund growth, attractive spreads? Or are you starting to see maybe a pullback or retrenchment from customers? We heard that from a smaller Texas back yesterday.

Just wanted to kind of get your kind of updated outlook and maybe if there's some conservatism baked in there. Thanks..

Thanks, Michael. I think there is some conservatism baked in there. I think we're just trying to be prudent, not really knowing what’s going to happen with the economic environment. What continued rising rates is going to do to loan demand.

We are in great markets, with expanding in Phoenix, we're excited about Fort Worth, the Dallas metro area continues substantial growth. We're seeing growth really across the Board in our markets. But we still feel like 10% growth is a good number. And hopefully maybe we can do a little better than that.

But we're just trying to be thoughtful about our approach here because the future is a little bit cloudy with what's going on in the economy..

Okay, great. And then maybe for Ben. Can you just kind of walk us through the updated expectations on the margin? Obviously, assuming a [$376 million] (ph) of Fed funds at the end of the year.

That would imply if you're going to have a margin somewhere where it was in the first half of the year that would apply some compression in the back half of the year if we don't get to that level of Fed funds rates, can you just walk us through the sensitivity and maybe some of the puts and takes so we can better understand how to think about the margins as we move forward? Thanks..

Sure. Good morning, Michael. Well, I think the -- we expect the margin to be relatively consistent with second quarter and some opportunity for expansion as rates come up.

As I mentioned, we did make some strategic deposit rate changes at the very end of the quarter to drive better deposit growth to fund our loan growth, which as we've all talked about, has been very strong. That beta I think will be -- we're modeling something in the neighborhood of 50% for the remainder of the year.

Most of that will come in money market, which is really where we see the most competition for our customer and where we have to be the most responsive. We don't have a different rate forecast, I think, than anybody else. So we're assuming the Fed continues to move and gets up to [$375 million] (ph), which is consistent with expectations.

The one other headwind we have is that, we did have about $1 million of NIM improvement in the quarter purely from loans coming off of non-accrual. So I never expect that to occur in my modeling or in my guidance. So netting that together, I haven't projected a big increase, but there's certainly opportunity..

That's very helpful. And then maybe just one final one from me, just on the ATM and credit card interchange, that was down pretty meaningfully Q-on-Q. Is there any sort of seasonality in there? I think what we've heard from some of the other banks that reported is, there is actually really positive trend.

So I was a little surprised to see that down as much as it was. Can you just give us any color there? Thanks..

Michael, it's a little deceptive. We have one substantial customer who really had outstripped volume, outsized volume for quite a while. That business in particular has slowed a bit. But if you look at our overall credit card portfolio, it is growing.

And we're growing clients and we're growing cards and the general trends in the overall portfolio are really good. We just had one large customer whose volume slowed a bit and it's just related to some seasonality of their business..

Okay. Thanks for the color. I appreciate it..

The next question comes from Brady Gailey from KBW. Please go ahead..

Thank you. Good morning, guys..

Hey, Brady..

Maybe one more just on the deposit rates. Your cost of deposits for the quarter was up to 42 basis points. I was just curious if you had the spot rate as you exited the quarter.

It sounds like you guys made some changes right there at [Technical Difficulty] but where's the starting point headed into 3Q?.

Brady, that would be just a little bit over 105 bps, 107 bps, in that neighborhood..

105, so cost of total deposits of over 100 basis points?.

I'm sorry, that's new money expectation. Give me just one second here. I'll tell you the spot and -- total deposits, Brady, 42 bps. Total funding, a little bit higher, right, when you add in our FHLB borrowings. Sorry, that's the 105 bps I was giving you. Deposits 42 bps..

Okay. And then, so Mike, I mean, when I listen to your comments, you promoted Randy, new General Counsel, new COO, new Head of Fort Worth, you're investing in technology. It feels like you all are spending a lot of money to kind of position the bank for the long term.

I'm just wondering, bigger picture, do you get the feeling that there is still a lot of continued investments that needs to be made -- needed to grow this franchise? Or have you done a lot over the last six months to the point where you can somewhat take a breather as far as investing in new initiatives for the bank?.

Yes. I think we have made a lot of the investments. And Brady, several of those positions are replacement positions. And for example, promoting Randy, there was no new net add of people. So, it was really more a reorganization and restructuring of our organizational chart.

The hiring of JC was something we've been looking at, it was something we budgeted. As we continue to expand, Amy Fauss, who is now our CHRO, who has run operations since 2009, just had to shed some of her titles as we grow and JC came from a really strong regional bank with a lot of experience.

So we think he'll really help us on the process and efficiency side. But yes, we've made much of the investment going forward more of it will be if we enter a new market, right? We'll be letting talent..

Okay. All right, great. Thanks for the color..

Thanks..

The next question comes from Jennifer Demba from Truist Securities. Please go ahead..

Thank you.

Can you just talk about what prompted you to conduct the loan review you discussed during the second quarter? And Ben, can you just talk about what your provision outlook you think could be in the second half of the year?.

Hey, good morning, Jennifer. This is Randy. I’m happy to answer that. We just looked at the rising rate environment Jennifer, and some of the negative economic data that was out there and said, let's put the portfolio through a stress test. Just felt like that was appropriate, given where we were in the economic cycle.

And we built out a fairly robust commercial real estate stress test model to run different scenarios through, so we're able to utilize that.

And on the C&I portfolio, we just looked at all borrowers of $10 million and above and stress those for interest rate and for drop in operating profit just to get a bit of an idea what early indicating -- early warning signs there were.

As we said in our comments, I mean, the portfolio held up very well through that stress test, but that was really the genesis behind that. Provision, as I said, we're in our second quarter under CECL. We're still learning a little bit how CECL reacts to different inputs.

As you know and you've heard from the other banks, the change in reasonable and supportable forecasts can move that provision quite a bit. But we would say that the provision level we had in Q2 would probably be representative of what we would expect in the remaining quarters..

Okay. Thanks so much..

The next question comes from Andrew Liesch from Piper Sandler. Please go ahead..

Hey, good morning, everyone..

Good morning, Andrew..

Just got a quick follow-up on the loan review.

Is that how you identified some of these loans that were -- that moved over to sub standards? Or is that -- are these loans already on your radar and you just felt that was a supply chain issues that substandard or perhaps how is the better rating?.

This is Randy. Good morning. So the one credit I referenced that had the supply chain issue had actually been identified prior to the stress test. And so, really the stress test did not show any material great changes in the portfolio. And again, we'll continue to monitor that.

That's not a one-time exercise, that's a continuing exercise as we get -- as companies start reporting Q2 numbers, we'll rerun that with updated information. So that was not a one-time event, but the other credit had been previously identified..

Andrew, I’ll just add. I mean, it's just something that we looked at and we want to make sure we're really appropriately reserved. And with rising rates, with inflation, with supply chain, with everything you read out there, we just really wanted to double down and make sure we didn't have any issues in our portfolio.

And knock on wood and much like you're hearing a lot of the banks, we're not seeing it show up yet in our customer base. And so, we're going to continue to closely monitor our portfolio. We're going to stay on top of it like we always do and really try to be proactive as we need to..

Got it. And I think that's a good move at this point in the cycle.

Ben, over the margin discussions follow-up there, I guess what are you guys seeing on the loan beta with all these rate hikes and passing on? You got the higher rates on the new loans? Or is a lot of that being competed away?.

Hey, good morning, Andrew. Well, probably the best fact to give you there is that, as I said, we're about 70% variable or repricing, 61% of that 70% I think is in the first 90days. So a lot of sensitivity in the loan portfolio.

We had 28 bps, right, of expansion in the loan yield quarter-over-quarter, as I said, I think we expect it to be -- to move in a similar pattern, right? As we see an increases here for the rest of the year. So we're really happy with the variability of the portfolio. And as I said in my comments, I think there's opportunity for expansion there..

Hi, Andrew, this is Randy. I would add to that, on the floating rate, I think we're seeing some expansion in margin. Deals are -- everything is competitive, but we're seeing a little bit more pricing than we had seen. A lot of movement from customers to look at fixed rates. So we're being cautious on that front.

But on the floating rate, we're seeing margin expand slightly..

Okay. Very helpful. Thanks for taking the questions here. I will step back..

Thanks, Andrew..

The next question comes from Matt Olney from Stephens. Please go ahead..

Thanks for taking the question. I wanted to follow-up on the loan growth topic. And I think Randy, you’ve mentioned the change of the utilization rates. I want to make sure I got this right. It was 42% in the first quarter and then increased of 50% in 2Q.

Did I get that?.

That's right, Matt..

And any color as far as any specific industries where you saw more considerable movements in 2Q? Because that's a pretty notable change for just one quarter overall..

Yes. And so, during the quarter we saw good balanced growth between CRE and C&I. You're asking specifically within C&I. Really within the C&I portfolio, we had good geographic diversity around our footprint and we also had good industry diversity. So there was no one outlier that had an increase.

And some of the top increases, Matt, were in engineering, financial services, healthcare and professional and technical services. So obviously, we watch that at the industry level and we saw broad based growth there. There was no one outlier..

Okay. Thanks for that Randy.

And then as far as the C&I credits that were impacted by the supply chain, any color on which industry that was mostly -- most focused on?.

Matt on that, it was a supplier to a big box sporting good. And as you've seen, a lot of the big box retailers got caught with high inventory levels and this client was caught up in that, where they're having the big box, guys are having to sell through some of that excess inventory before they restart purchasing at the same level.

So that's the segment..

Okay. Appreciate that. And then circling back to the funding strategy. It looks like the funding strategy in 2Q was to utilize some borrowings and take down some liquidity. As we roll into the third quarter, it sounds like you've already updated deposit pricing.

So should we assume that the loan growth in the third quarter should be primarily funded by deposit growth from here?.

Matt, that's the goal, right? Over the past 18 months we really were able to run off a lot of wholesale funding due to our core deposit growth.

And so, in the second quarter, we did add a little bit of that back, but we're still going to fund our loan growth with core deposits and we've put deposit pricing in place to do that and really proud of the fact that we've grown DDA 42% over the last 12months.

And so, we're going to continue to focus on growing checking accounts and funding our balance sheet with core deposits. When you open new markets, the loan growth always comes a little faster than the deposit growth.

And so, Phoenix, for example, although they're doing a fantastic job, they're basically almost funding themselves, has had tremendous loan growth, but deposit growth always lags a bit. And so, all that will rationalize over time..

Okay. And just following up on that. I think Ben mentioned earlier in the call some of the new deposit pricing, just over 100 basis points for some of the new money coming in.

I'm curious how does that compare for some of the wholesale channels that are also an option for the back half of the year?.

I think that number Matt was a wholesale number he gave you..

Yes, they're pretty comparable, Matt, not a huge amount of difference between wholesale and what we would pay for new money at retail. It's our goal generally for those to be in a similar range..

Okay. That's all from me guys. Thank you..

Thanks, Matt..

[Operator Instructions] There are no more questions in the queue. This concludes our question-and-answer session. I'd like to turn the conference back over to President and CEO, Mike Maddox for closing remarks..

I want to thank everybody for joining us today. Really, really proud of our quarter. As I said earlier, we're very well positioned for the rest of the year and beyond. We're very excited about the opportunity to add a terrific team of bankers to the CrossFirst family in Colorado and New Mexico.

That opportunity will provide us great core funding and access to some really dynamic markets. So just really proud of team and just, again, I want to thank you all for joining us and I look forward to talking to you at the end of the third quarter..

Please direct any follow-up calls to heather@crossfit.com. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect..